As proxy season heats up -- of particular interest will be a whole new category of "say on pay" shareholder proposals -- proxy advisory firm Institutional Shareholder Services (ISS) is under unprecedented scrutiny. That includes possible -- and, in my view, unnecessary -- new regulatory requirements from the SEC.
ISS is often described as "influential," and public companies frequently complain that too many institutional investors vote their shares according to ISS recommendation without any independent evaluation. They also complain about conflicts of interest because ISS does consulting work for some of the companies it evaluates. The industry-sponsored Center on Executive Compensation sent a letter to institutional investors urging them to grill ISS about its conflicts. Oddly enough, the center was silent about its own conflicts.
I was the fourth person hired at ISS, back in 1986, and was its general counsel and briefly its CEO before leaving to join its founder, Bob Monks, in the second of our three business ventures. I well remember Bob explaining to me his original vision for the role of institutional investors in corporate governance.
Investors got smart... and organized
I had never heard either of those terms before, and it all seemed very idealistic and far-fetched. But we were there at the moment of collision between the takeover-era corporate raiders and entrenched managers on the one hand and increasingly enlightened and activist investors on the other. These investors were smart enough to know when they had been mistreated, obligated as fiduciaries to respond, and big enough to make that response matter.
In those days, shareholder initiatives could seldom garner enough votes to make them eligible for resubmission the following year. Now shareholders are voting down excessive pay plans and vetting director candidates.
ISS has been a part of that, growing from our four-person, one client operation in 1986 to a world-wide enterprise advising institutional investors on proxy and other governance issues, at one time a public company itself as a part of RiskMetrics and now a subsidiary of MSCI. And, with its rival Glass Lewis, proxy advisory services have become so influential that advisors will claim victory about a 70 percent majority for a compensation plan, one that what a few years ago would have resulted in a routine vote high in the 90s.
What ISS critics get wrong
The corporate critics of ISS have largely failed to make a credible or coherent argument. They complain that ISS is too influential, even though their own numbers show that it sways no more than 20 percent of the vote. Other data suggest that the more controversial the issue, the more ISS clients review their analysis and come to their own conclusions.
Of course, companies don't mind ISS's influence when -- as in the vast majority of cases -- the firm recommends a vote in favor of management.
ISS is often accused of being too rigid and formulaic. There is some justification for this; it relies on formulas to demonstrate that it is not swayed by conflicts from its consulting fees. But ISS is also criticized for departing from its formula. This is absurd; no formula should take precedence over concerns about performance.
What ISS critics get right
In my opinion, though, ISS really shouldn't do consulting work for companies it covers. I didn't allow it when I was CEO of ISS, and I didn't allow it at The Corporate Library. I often disagree with the analysis and recommendations of ISS (they recommended against me a couple of times, for example). But I'm comfortable letting its customers make that call. I remember how long we waited for our second client -- the first was an old friend of Bob's who took pity on us -- and I'm proud of how far they've come.
ISS has produced a 25th anniversary book (free to download, but registration required) with essays by 25 of the very best, brightest, and most insightful in the world of corporate governance. Highlights include:
- Bob Monks, Ralph Whitworth of Relational Investors, and Hye-Won Choi of TIAA-CREF on the investor side;
- Peggy Foran of Prudential, Martin Lipton of Wachtell, Lipton, Rosen and Katz, and Ken Bertsch of the Society of Corporate Secretaries and Governance Professionals on the corporate executive side;
- Charles Elson of the University of Delaware's Weinberg Center for Corporate Governance and Ira Millstein and Holly Gregory of Weil, Gotshal, and Manges on boards of directors;
- And an international perspective from Knut Kjaer of the Dutch fund ABP, the largest pension fund in Europe and Andre Baladi, co-founder of the International Corporate Governance Network, the world's leading association of institutional investors.